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State Aid and Guarantees in Europe

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The Palgrave Handbook of European Banking

Abstract

During the recent financial crisis, governments massively intervened in the banking sector by providing liquidity assistance and capital support to banks in distress. This helped stabilize the financial system in the short run. However, public bailouts also bear the risk of longer-term distortions, for example, by affecting bailout expectations of banks. In this chapter, the authors first provide an overview of state aid interventions during the recent crisis episode. The third section then analyzes the effects of state aid on financial stability from a theoretical view. This is followed by the description of results obtained from empirical studies. The link between the provision of state aid and politics is discussed in the section “Institutional Design and Policy Implications”. Finally, in the section “The European Banking Union” the authors describe the elements of the European Banking Union meant to resolve and restructure banks in distress and to lower the need for public intervention. Based on the preceding analysis, conclusions are drawn regarding the new design.

JEL Codes: G21, G28, G32

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Notes

  1. 1.

    In 1984, the term “too-big-to-fail” (although already existing) gained prominence in the context of the rescue of Continental Illinois Bank due to the congressman Stewart B. McKinney who said: “We have a new kind of bank. It is called too big to fail. TBTF, and it is a wonderful bank” (Farber 2012). The term “too-interconnected-to-fail”, in contrast, became prominent during the recent crisis following the failure of Lehman Brothers or the collapse of Bear Stearns and the resulting spillovers (Taylor 2014).

  2. 2.

    Data come from the State Aid Scoreboard of the European Commission: http://ec.europa.eu/competition/state_aid/scoreboard/financial_economic_crisis_aid:en.html.

  3. 3.

    We define the country groups as follows: GIIPS comprises Greece, Ireland, Italy, Portugal and Spain; Eastern Euro comprises Latvia, Lithuania, Estonia, Slovakia and Slovenia; Remaining Euro comprises Belgium, Germany, France, Cyprus, Luxembourg, Malta, the Netherlands, Austria and Finland; Non-Euro comprises Bulgaria, Czech Republic, Denmark, Croatia, Hungary, Poland, Romania, Sweden and the UK. To calculate the total amount used, we take the sum of (1) recapitalization measures and asset relief measures over the period 2008–13, and (2) outstanding guarantees and other liquidity support measures in the EU-28 peak year 2009.

  4. 4.

    Looking at either asset relief measures or recapitalization measures separately reveals that the share of asset relief (recapitalization) measures of GIIPS countries amounted to 21% (40%) compared to 58% (34%) for the remaining Eurozone countries.

  5. 5.

    Detailed information on TARP can be found at: http://www.treasury.gov/initiatives/financial-stability/about-tarp/Pages/default.aspx, with the distribution of the granted money across the five programmes described here: http://www.treasury.gov/initiatives/financial-stability/about-tarp/Pages/where-did-the-money-go.aspx

  6. 6.

    See, for example, http://www.theguardian.com/business/blog/2008/oct/15/banking.

  7. 7.

    The Bank Investment Programs are explained at: http://www.treasury.gov/initiatives/financial-stability/TARP-Programs/bank-investment-programs/Pages/default.aspx

  8. 8.

    See http://ec.europa.eu/competition/state_aid/scoreboard/financial_economic_crisis_aid:en.html.

  9. 9.

    See also the section “Vulnerability to Runs” in Chap. 12.

  10. 10.

    Allen et al. (2015a) provide an excellent discussion of these assumptions and resulting limitations.

  11. 11.

    For example, there are papers which study panic- and fundamentals-based runs (see, for example, Gorton 1988; Jacklin and Bhattacharya 1988; Allen et al. 2015b; see also Chap. 12 of this book). The effect of limited commitment is studied in Cooper and Kempf (2016). Competition for deposits under deposit insurance or the pricing of deposit insurance is analysed by Matutes and Vives (1996) and Freixas and Rochet (1998). A more detailed overview of the literature is provided by Allen et al. (2011).

  12. 12.

    Further factors behind moral hazard and bank risk-taking are discussed in the section “Moral Hazard and Excessive Risk-Taking” in Chap. 12.

  13. 13.

    Agency problems due to ownership status and effects on profitability, risk and lending are presented in more detail in Chap. 3.

  14. 14.

    Freixas et al. (2000) provide a model in which banks with a key position in interbank markets are subject to a “too-big-to-fail” policy and rescued by the central bank to ensure the functioning of payment flows.

  15. 15.

    Acharya and Yorulmazer (2008) propose that instead of directly bailing out banks, the government should grant liquidity to surviving banks such that they acquire failed banks. This lowers banks’ incentives to herd and the probability of banking crises. However, this support should be conditional on surviving banks’ liquidity holdings, otherwise they might have incentives to hold less liquid resources (Acharya et al. 2011).

  16. 16.

    For a general discussion on the relation between competition and banking stability see Chap. 7.

  17. 17.

    For example, Keeley (1990) shows for US banks that if competition increases, risk-taking increases under a deposit insurance scheme due to reduced interest margins. Wheelock (1992) or Wheelock and Wilson (1995) find a higher probability of failure for US banks in the 1920s and 1930s due to membership in the deposit insurance system. Ioannidou and Penas (2010) show that after the introduction of deposit insurance in Bolivia in 2001, banks grant riskier loans without asking for higher collateral.

  18. 18.

    In a related study, Koerner and Schnabel (2013) also document an increase in funding costs for German savings banks. They assign this to spillovers from German Landesbanken, which have also been affected by the removal of guarantees and transmitted increased costs within the network of interrelated savings banks.

  19. 19.

    Also, Sironi (2003) shows that subordinated debt holders price risk appropriately except for public banks suggesting that they benefit from public guarantees. However, De Nicoló and Loukoianova (2007) do not find that public banks behave in a more risky manner than private banks.

  20. 20.

    The funding cost advantage for “too-big-to-fail” banks has also been shown by Ueda and Weder di Mauro (2013). Boyd and Gertler (1994) find higher risk-taking among the largest banks in the USA.

  21. 21.

    For a sample of Italian banks, Sapienza (2004) shows that government-owned banks grant cheaper loans to larger firms, providing evidence for a misallocation of financial resources.

  22. 22.

    A more detailed discussion on resolution schemes can be found in Chap. 12.

  23. 23.

    Summary information on the structure of the Banking Union can be found at: http://bankinglibrary.com/e/fdz/IntBankLib/regulation/monitoring.asp; http://ec.europa.eu/finance/general-policy/banking-union/index_en.htm.

  24. 24.

    See http://www.consilium.europa.eu/en/policies/banking-union/single-resolution-mechanism/

  25. 25.

    See for example: http://www.federalreserve.gov/bankinforeg/resolution-plans.htm.

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Authors and Affiliations

  1. Halle Institute for Economic Research (IWH), Member of the Leibniz Association, Kleine Maerkerstraße 8, 06108, Halle, Germany

    Reint Gropp

  2. Otto von Guericke, University Magdeburg, Magdeburg, Germany

    Reint Gropp

  3. Otto von Guericke, University Magdeburg, Kleine Maerkerstraße 8, 06108, Halle, Germany

    Lena Tonzer

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  1. Reint Gropp
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  1. Cass Business School, City University London Cass Business School, LONDON, United Kingdom

    Thorsten Beck

  2. Faculty of Finance, Cass Business School-City Universit Faculty of Finance, London, United Kingdom

    Barbara Casu

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Gropp, R., Tonzer, L. (2016). State Aid and Guarantees in Europe. In: Beck, T., Casu, B. (eds) The Palgrave Handbook of European Banking. Palgrave Macmillan, London. https://doi.org/10.1057/978-1-137-52144-6_14

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